Correlation smile
Investors are not being sufficiently rewarded for the risks they take in buying junior mezzanine tranches, as the implied correlation levels of such tranches demonstrate
Investors are not being properly compensated for the risk of buying equity andjunior mezzanine tranches, according to Deutsche Bank’s quantitative creditstrategy group. The chart above, known as the ‘implied correlation smile’,shows the current strength of demand for equity and mezzanine tranches, as illustratedfor the 0–3% and 3–6% tranches of the iTraxx Europe index. For example,implied correlation levels for the 3–6% tranche are lower than for allother tranches and fell from 6.6% to 4.4%
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